Evidence of China stimulus positive for emerging market assets

June 30, 2020 06:00
China's robust credit and monetary aggregates for May indicate that more aggressive policy support is now being implemented. Photo:Reuters

Last month we cut slightly our forecast for China GDP growth this year to 1% because sectors of the economy, particularly services, appeared to be recovering more slowly in the second quarter than we had previously anticipated. However, we have remained positive on our outlook since a large monetary and fiscal stimulus was likely to drive the recovery in the second half of this year.

Robust credit and monetary aggregates for May indicate that more aggressive policy support is now being implemented. Growth in total social financing has accelerated to 12.5% y/y last month, from 12% y/y in April, on the back of a sharp increase in the issuance of special bonds by local governments. A v-shaped rebound in heavy vehicle sales in April had already hinted that government-driven investment projects were getting under way in earnest and it seems that there would be more to come.

There was also a steady increase in more traditional renminbi-denominated bank lending last month which ought to give broader support to the recovery. All of these financial policy activities meant that there was another increase in credit and, as we flagged last month, lower interest rates ought to ensure further gains in the coming months. Meanwhile, growth in M1 money supply also accelerated last month, to 6.8% y/y from 5.5% y/y in April.

Encouragingly, a simple model based on interest rates and the required reserve ratios for banks points to a sharp acceleration in real M1 growth in the months ahead. The model is far from perfect and there are of course other intermediary non-monetary factors such as confidence, social distancing, weak external demand and friction with the US that might still weigh on the recovery. Nonetheless, the direction of the travel trend seems clear and there ought to be a significant improvement in economic activity as the year progresses.

An acceleration in the growth of credit and monetary aggregates would usually be a bullish signal for Emerging Market assets. There is a good correlation between real M1 growth and hard currency bonds and our model points to much tighter spreads.

What happens in the rest of the world will also matter and lingering uncertainty about the outbreak of the Covid-19 pandemic remains a major bone of contention. However, our belief that long-term interest rates in developed markets will remain low for the foreseeable future is consistent with a sustained period of inflows into EM assets. While we remain cautious about extending too far into low-rated markets given that it is still difficult to accurately assess the fall-out from the coronavirus crisis, but some of the major drivers of EM markets certainly appear to be aligning favourably.

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Managing Director Head of Trading & Treasury, Asia at Bank J Safra Sarasin